Some businesses are (unpleasantly) surprised when they learn they are responsible for taxes -such as sales and income taxes - in states in which they have no physical presence. What gives rise to liability in these situations is “economic nexus,” which relates to a business’ activity, such as the generation of sales without a physical presence, in a state. Nexus, therefore, can be a hidden trap for businesses with multistate sales and other activities, particularly because what gives rise to nexus is often uncertain and unexplained by a state’s taxing authority.
Michigan Department of Treasury (the “Treasury”) has shed light on what constitutes nexus in Michigan through the issuance of a release that explains the nexus standards for Michigan business taxes. The release (the “Release”) addresses the sales and use tax presumption for out-of-state sellers; the nexus standards for the corporate income tax; and the nexus standards for flow-through entity withholding.
Sales and Use Tax Presumption - Out of State Sellers
The Treasury explained that a seller is responsible for use tax collection if it has a physical presence in Michigan. Regarding sales tax, the Treasury noted that an out-of-state seller will be “presumed engaged in the business of making retail sales in Michigan” - thereby creating a nexus and giving rise to Michigan sales tax liability - if the seller, or another person, including an affiliated person (as defined in the Release), performs any one of a series of activities described in the Release in Michigan. These activities include things such as:
- Sells a similar line of products as the seller and does so under the same business name as the seller or a similar business name as the seller.
- Maintains, occupies, or uses an office, distribution facility, warehouse, storage place, or similar place of business in this state to facilitate the delivery or sale of tangible personal property sold by the seller to the seller’s purchasers in this state.
- Shares management, business systems, business practices, or employees with the seller, or in the case of an affiliated person, engages in intercompany transactions related to the activities occurring with the seller to establish or maintain the seller’s market in this state.
While the activities described in the Release create a presumption that a business is engaged in the business of making retail sales in Michigan, the presumption may be rebutted “by showing that an activity is not significantly associated with the seller's ability to establish or maintain a market in Michigan.”
Corporate Income Tax
There are three nexus standards under the Michigan Corporate Income Tax.
- First, there is a nexus if a business has a “physical presence” in Michigan for more than one day,
- Second, if the business “actively solicits” sales in Michigan and has gross receipts of $350,000 or more sourced to Michigan, or
- Third, if the business has an ownership or beneficial interest in a flow-through entity (directly or indirectly through one or more flow-through entities) which has substantial nexus in Michigan.
The Release describes the nexus standards for flow-through withholding as follows:
Flow-Through entities with business activities beyond those protected by federal PL 86-272 are required to withhold Individual Income Tax on every member that is a nonresident. This withholding is done at the Individual Income Tax rate on the distributive share (after allocation or apportionment) that is reasonably expected to accrue to the nonresident individual. Also, effective January 1, 2012, a flow-through entity with business activities beyond those protected by federal PL 86-272 and that reasonably expects to accrue more than $200,000 in apportioned or allocated business income for the tax year is required to withhold Corporate Income Tax on the distributive share of its members that are C-corporations or other flow- through entities in a tiered structure.
The Release includes additional information and definitions related to certain terms, such as the meaning of an “affiliated person,” so businesses that may have a nexus in Michigan should closely review the Release with counsel in order to understand their obligations and responsibilities regarding Michigan business taxes.